BOND REPORT: Treasury Yields Slide After Second-quarter GDP Data

Treasury prices recovered from earlier weakness on Friday, pulling down yields after a rebound in second-quarter economic growth, but a lack of accompanying inflation and wage growth cast doubt on the likelihood of another rate increase this year.

The yield on the benchmark 10-year Treasury note fell less than 2 basis points to 2.294% from 2.312% in the previous session, while the yield on the 30-year Treasury bond, lost around 3 basis points to 2.898%, compared with 2.928% on Thursday.

The yield on the 2-year note was flat at 1.355%. Yields rise as debt prices decline.

Treasury yields fell slightly after data showed second-quarter gross domestic product grew at a 2.6% annual pace, below the consensus forecast of 2.8% by economists polled by MarketWatch. While the number is more than double the revised 1.2% pace seen in the first quarter, it leaves the U.S. economy on a tepid expansion path.

See: U.S. GDP speeds up to 2.6% in 2nd quarter (http://www.marketwatch.com/story/us-gdp-accelerates-to-26-in-second-quarter-2017-07-28)

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Though the overall economic report offered notes of optimism, the personal-consumption expenditures index, the Fed's preferred measure of inflation, only notched a gain of 0.3%, a sharp slowdown from 2.2% in the first quarter. While, the latest U.S. employment cost index, a measure of wage pressures, rose 0.5% (http://www.marketwatch.com/story/us-employment-costs-rise-05-in-2nd-quarter-eci-shows-2017-07-28), slightly below forecasts. A trend of easing price pressures but strengthening growth could prove worrisome to economists adhering to the Phillips curve, a theory that ties slack in the labor market to wage growth, and thus, inflation.

"This suggests that even if we're in a lower productivity environment, there has been a breakdown in the transfer mechanism between wage growth and realized inflation," noted Ian Lyngen, head of U.S. rates strategy for BMO Capital Markets.

The lack of inflation offered fodder for the bond bulls as they engaged in modest buying after the data's release. Higher consumer prices can have a corrosive effect on the fixed-payments of government paper. Analysts say the prospect for another rate increase this year remains uncertain.

"The market has lost a little faith that the Fed can raise rates, the dot plot has adjusted more to market expectations," said Andrew Chan, a portfolio strategist at First Foundation Advisors. The so-called dot plot refers to Fed member's projections for future interest rates.

Market participants argue the U.S. central bank's actions hinge on inflation and growth developments, after previous statements in which members of the Federal Open Market Committee said interest rate increases were data-dependent. Further rate increases could weigh on Treasury prices, as older issuance moves to a discount to match the higher yields of new bonds.

Traders in the Fed fund futures markets nonetheless appeared to think the mixed economic data would give impetus to the hawkish elements of the Fed's interest-rate setting body. More investors are betting on one more rate increase by December. Traders' expectations of another rate increase in December rose to 44.6% after the data release (http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html) from 42.8% on Thursday, according to the Chicago Mercantile Exchange's FedWatch tool.

But small changes in futures data can be deceptive as the market is thinly traded, said Marvin Loh, fixed-income strategist for BNY Mellon.

Elsewhere, the German 10-year benchmark bond, known as the bund, jumped close to 4 basis points to 0.540% after eurozone economic sentiment rose in July for a third straight month to set a fresh 10-year high.